No insurance coverage for attorneys’ fees that were ordered as a “sanction”

If you or your firm were ordered to pay a party’s legal fees as a “sanction” for professional misconduct, would your professional liability insurance cover that payment?

In a recent case, the district court for the Northern District of Illinois left a law firm high and dry, holding that the policy exclusion for sanctions meant that the insurer did not have to cover attorneys’ fees that its insured, the law firm, had to pay or repay due to its misconduct. Edward T. Joyce & Assocs., P.C. v. Professionals Direct Insurance Co. (PACER identification required for access).

Underlying case

In the long and tortuous underlying case, which began in 2002, the Joyce Firm represented more than 100 individuals and entities as plaintiffs under a contingent fee agreement. After obtaining an arbitration award against the insolvent defendant, the Joyce Firm hired additional co-counsel to help in the second phase of the case by pursuing a claim against the defendant’s insurer. The firm attempted to modify the original fee agreement in 2007, including adding a provision for an “hourly contingent fee.” Eventually, the claim against the insolvent defendant’s insurer resulted in an $8.6 million settlement in favor of the plaintiffs.

Plaintiffs, however, disputed the amount and basis of the Joyce Firm’s fees arising from that settlement, and also disputed who was responsible for paying the additional co-counsel’s fees. Plaintiffs demanded arbitration, seeking, among other things, “equitable disgorgement.” The arbitrator found several instances of misconduct on the part of the Joyce Firm:

it failed to advise the clients to consult independent counsel about the attempted modification of the fee agreement;

it failed to give adequate information about the terms of the new agreement to the many clients;

it presented the new agreement on a take-it-or-leave-it basis; and

the new agreement was not in writing.

The arbitrator determined that “as a sanction,” the Joyce Firm was responsible for paying 25 percent of the co-counsel’s fees, or about $150,000; because the firm’s actions were “not intentional,” though, the plaintiffs were responsible for the remainder. The Joyce firm was also ordered as “a sanction” to repay to the plaintiffs more than $405,000 in fees it had previously collected as “contingent hourly fees” under the attempted 2007 modification of the fee agreement. The trial court confirmed the arbitration award, the court of appeals affirmed, and the state supreme court denied a petition for leave to appeal.

Policy exclusion for “sanctions”

The Joyce Firm was insured under a professional liability policy that excluded from coverage (among other things) “any claim for fines, sanctions, penalties, punitive damages or any damages resulting from the multiplication of compensatory damages.” Although the firm’s insurer agreed to reimburse it for defense costs, the insurer denied any further obligation to indemnify the Joyce Firm — particularly against the more than half million dollars the arbitrator awarded to plaintiffs as a “sanction.”

The Joyce Firm’s resulting declaratory judgment action against the insurer was removed to the District Court for the Northern District of Illinois. There, the district court granted summary judgment in favor of the insurer.

“Sanction,” not “disgorgement”

The Joyce Firm argued that despite the arbitrator’s use of the term “sanction,” he really intended the damages to be in the nature of disgorgement, as he found that the firm did not intend to violate the law or the rules of ethics. (Indeed, “disgorgement” would have been in line with the way the plaintiffs characterized the recovery they sought.)

The district court summarily rejected that argument, citing the arbitrator’s “stated imposition of sanctions,” and the state court of appeals’ affirmance of the arbitration award, which “expressly and repeatedly referred to the damages award as a sanction.” These characterizations were apparently sufficient for the district court; the opinion cites no case authority in support of this prong of its ruling that the insurer had no duty to indemnify the Joyce Firm.

Take-aways: (1) words matter; (2) mind your fees and cues

The Joyce Firm appealed to the Seventh Circuit Court of Appeals on October 23, so the final chapter has not yet been written on this case. But one take-away from the district court’s ruling is that words certainly matter, and that the way in which an arbitrator characterizes an award can have a large impact on insurance coverage issues. The other take-away concerns the law firm’s attempt to modify its contingent fee agreement. Model Rule 1.5(b) requires that once agreed to, any change in the basis or rate of the fee must be communicated to the client. That was apparently not carried out adequately in this case, providing one of the implicit bases for the arbitrator’s award against the firm.

Karen is a member of Thompson Hine’s business litigation group. She is a member and former chair of the Certified Grievance Committee of the Cleveland Metropolitan Bar Association, and a member and past chair of the Ohio State Bar Association’s Ethics Committee. She also chairs that committee’s Ethics Opinions subcommittee, and has authored several ethics opinions on behalf of the OSBA interpreting the Ohio Rules of Professional Conduct. Karen also is an adjunct professor at Cleveland-Marshall College of Law, teaching legal ethics.

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